Fiscal Policy for the Lower Middle Class

KOMPAS/HERU SRI KUMORO

Muhamad Chatib Basri

We may live in an age of haste and unpreparedness. With the COVID-19 pandemic comes the hard lesson that we are fragile.

Governments in a number of countries are trying to issue policies to tackle the outbreak, Indonesia is no exception. The government of Indonesia has enacted a regulation in lieu of law (Perppu) that focuses on three things: health, social assistance and economic recovery. Government steps need appreciating.

I once wrote in this daily (19/3/2020) that COVID-19 and social restrictions will have an impact on the economy, both due to demand shock -- due to decreases in income -- and supply shock -- due to disruption of production activities. In such a condition, fiscal policy must be adjusted to the condition and policy priorities. And the government fiscal policy which is included in the Perppu is indeed focused on answering the issues.

However, as stated by my colleagues, Rema Hanna and Benjamin Olken, in the two previous writings, the current social protection is not yet enough. Social protection needs to be expanded to the lower middle income group. Rema Hanna wrote that the social protection programs in Indonesia are currently focused on those who are poor, and not those of the lower middle class who are vulnerable to poverty. These programs are also designed not for those who have lost their jobs due to economic shocks, such as Covid-19. Therefore, the existing social assistance programs need to be expanded.

Also read : Stimulus amid the Coronavirus

Fiscal space

Benjamin Olken wrote that there needs to be a new approach to address the issues raised by Rema Hanna. Olken proposed three policy options: expanding the Pre-Employment Card program, utilizing mobile digital technology, and using a community-based approach as one of the guidelines in providing assistance to the lower middle class group who are vulnerable to Covid-19.

The question is whether there is a fiscal space for that? How do we finance it? This article tries to answer that question. Possibly there are several things that can be done.

KOMPAS/ERIKA KURNIA

A line of dozens of drivers, street vendors, workers at Depok Terminal to receive lunch assistance on Wednesday (15/4/2020). Assistance is provided by the social organization Aksi Cepat Tanggap (ACT) and the Indonesian Volunteer Society.

First, the government\'s steps to reallocate the budget and focus on the three main priorities are already appropriate. However, perhaps the priorities can be further sharpened. Government programs, including infrastructure projects, physical spending, or non-urgent capital expenditure, are postponed first. Ministries and agencies\' budgets can be cut further. Budgets with limited effectiveness can also be cut.

In the situation of the large-scale social restrictions like this, most business travels will be stopped. Meetings can be held online. Tax relaxation is also not fully effective because if workers are laid off or the companies are in loses, they still cannot take the benefit from this policy. It is better that the budget, which is also sourced from taxes, is allocated to the lower middle class. Priorities must be really sharp, focusing only on the three main things that have been mentioned earlier. Beyond that, wait after the situation returns to normal.

Also read : Designing the Assistance Program for the Lower Middle Class

Second, Indonesia does need a bigger budget deficit. The government has removed the maximum budget deficit of 3 percent of gross domestic product (GDP) for three years. The government has allocated a budget to deal with Covid-19 at Rp 405 trillion (2.5 percent of GDP). This funding allocation is for: additional health budget of Rp 75 trillion; Rp 110 trillion for additional social safety nets, Rp 70.1 trillion for industrial support, and Rp 150 trillion for economic recovery.

If the social assistance program is to be extended to the lower middle class vulnerable to being hit by Covid-19, as proposed by Rema Hanna and Benjamin Olken, more funding is needed. For example: The World Bank (2020) estimates that there are 115 million people in the "aspiring middle class" category. If this group is to be targeted, the assistance needs to be provided to around 30 million households. If the value of benefits is Rp 1 million per month and is given for four months, then Rp 120 trillion or around 0.75 percent of GDP is needed. If this is done, the budget deficit will increase from the current government estimate of around 5.07 percent of GDP.

Also read : Expansion of Social Protection to Lower Middle Class

In the current situation, an increase in the larger budget deficit is something that can still be justified. The motto of the current fiscal policy in many countries in the world is "whatever it takes".

Possibly there are concerns that a large deficit will jeopardize the fiscal in the future. The current condition is not normal. The most important thing is that the pandemic can be overcome. If the economy does not work, the economic growth is negative, debt to GDP ratio also continues to increase. Meanwhile, if the budget allocation is right -- used for health, social protection, economic recovery -- the market can accept and the economy will recover faster.

Third, if the budget deficit increases, then how is the financing? The first thing to do is utilizing existing funding sources in the government, such as excess budget balances, Public Service Agency funds, and so on. Of course this is not enough. Therefore, the government needs to issue bonds. If we only rely on the domestic bond market, there will be a crowding out because bank funds will be absorbed by government bonds so that the banks will experience liquidity problems.

However, at this time demand for credit is also declining due to disruption of production activities. As a result, bank liquidity pressures also decline. Therefore, the space for financing through domestic bonds is actually more open than a few months ago.

Another option is by issuing bonds for global markets. A few weeks ago, the government issued the global bonds. The market responded positively. However, in the future, in a world economic situation that may decline, bond interests will be very high. Therefore, choosing a momentum to issue the bonds is important.

Also read : Technical Guidelines Should be Immediately Issued

Another option is the helicopter money, a term created by Milton Friedman in 1969. One of the examples is by asking Bank Indonesia to buy government bonds on the primary market. This idea is popular now but must be careful.

We know, conceptually, in a state of recession or depression (Keynesian range), where people are unemployed and the economy is far from full employment (a condition where resources are fully used), the method of "printing money" -- by asking Bank Indonesia to buy government bonds -- will indeed increase the money supply. This type of funding source can finance the budget deficit without causing significant inflation. However, remember that Covid-19 is a combination of demand shock and supply shock. If money is printed in very large quantities, continuously and when production (aggregate supply) falls or stagnates, inflation will increase. Therefore, caution is needed for this financing pattern.

KOMPAS/AGUS SUSANTO

An ojek (motorcycle taxi) driver distributes food and cash aid to Mardiyo, who was affected by Covid-19, in Duren Jaya village, Bekasi, West Java, on Thursday (16/4/2020). With the implementation of large-scale social restrictions (PSBB), The West Java provincial administration has started distributing aid through PT Pos Indonesia with the help of ojek drivers.

International cooperation

Fourth, another option is international cooperation. Until 2014, the Government of Indonesia had a facility called Deferred Draw Down Option (DDO), where if the interest on bonds in the market is very expensive, the Government of Indonesia can borrow from the World Bank, Asian Development Bank (ADB), Australia and Japan at very low interest. This scheme might be revived. With that, there is access to funding which is relatively inexpensive. Moreover, the possibility of support from AIIB, or bilateral support such as bilateral currency swaps, can be explored. I think we need to give appreciation to Bank Indonesia for getting a repurchase agreement (repo) facility from the US Central Bank of US$60 billion.

Beyond that, international cooperation is needed. The world\'s finance ministers and central bank governors must work together to ensure the availability of a global financial safety net. Carmen Reinhart and Kenneth Rogoff from Harvard University even proposed the need for a temporary moratorium on debt payments from emerging markets or developing countries. This debt installment interest can be used temporarily to overcome the Covid-19 problem.

Fifth, we want to remind that the execution of programs with large funds, including economic recovery, must be done on a rule-based basis. The criteria must be clear and good governance must be in place. Of course clear protection for implementers is absolutely needed. If not, the execution will cause problems. But in this regard, the emphasis on clean governance is very important.

The Covid-19 outbreak does have a lot of stories about death, loss of income, unemployment and tears. We know, in this anxious situation, we cannot help everyone. However, at least, as Rema Hanna wrote in a previous article: Do not let the greatest sacrifice be borne even by those who are the most vulnerable.

Muhamad Chatib Basri

Lecturer at the School of Economics and Business, University of Indonesia.